The Impact of Consumption on an Investor�s Strategy under Stochastic Interest Rate and Correlating Brownian Motions

Abstract

In this work, we consider that an investors portfolio comprises of two assets- a risk-free asset driven by Ornstein-Uhlenbeck Stochastic interest rate of return model and the second asset a risky stock with a price process governed by the geometric Brownian motion. It is also considered that there are withdrawals for consumption and taxes, transaction costs and dividends are in involved. The aim was to investigate the effect of consumption on an investors trading strategy under correlating Brownian motions. The relating Hamilton-Jacobi-Bellman (HJB) equation was obtained using maximum principle. The application of elimination of variable dependency gave the optimal investment strategy for the investors problem. Among the findings is that more fund should be made available for investment on the risky asset when there is consumption to keep the investor solvent.